For those interested in issues such as climate change, social inequity, and the financial crisis, join me in a dialogue to explore the challenges and opportunities associated with sustainability and the role of business in a sustainable society.

Monday, August 10, 2015

How to Evaluate Corporate Sustainability Reports

In today’s business environment, there has emerged an
unprecedented expectation on companies to provide explicit information on their
performance across the triple bottom line.
Consumers, employees, investors, civil society, government, and the
media are increasingly interested in knowing how companies shape up when it
comes to things like resolving social issues, reversing environmental
degrading, and stemming unethical practices in their supply chain. In response, many companies now publish
Sustainability Reports (also called Corporate Social Responsibility Reports or
Corporate Citizenship Reports) that, in theory, set out to mimic the highly
institutionalized and reliable financial statements by presenting their
performance along non-financial indicators.

In the last decade alone, the number of companies listed on
the S&P 500 index publishing sustainability reports increased from 47% in
2005 to 92% in 2015. According to KPMG,
whereas only 25% of the top 250 companies reported on sustainability in 1999, 93%
of these companies report on sustainability as of 2013. The increase has been truly unprecedented. By region, sustainability reporting has
increased dramatically in Asia Pacific over the last 2 years with 71 percent of
companies now publishing reports (an increase of 22 percent since 2011 when
only 49 percent did so). Due to an
increase in reporting by companies in Latin America, the Americas have now
surpassed Europe as the leading reporting region where 76 percent of companies
now report, followed closely behind by 73 percent in Europe and 71 percent in
Asia Pacific. KPMG concludes that
sustainability reporting “is now undeniably a mainstream business practice
worldwide, with 71 percent of the top 100 companies across 41 countries
reporting on sustainability. Whereas in
2011 less than half of the sectors in the world could claim that 50 percent of
their companies reported on sustainability, by 2013 all sectors have reported
that at least half of all top companies in each sector report on
sustainability. Major gains were seen by
the automotive and telecommunications & media sectors with increases of 28
percentage points in both sectors.

A KPMG survey conducted two years earlier asked CEOs to identify what was
motivating them to report on sustainability and found that the primary
motivation was reputation and brand (67% of respondents indicated this reason),
followed by ethical considerations (58%), employee motivation, and innovation
and learning (44%). Other popular
motivations included risk management or risk reduction, access to capital or
increased shareholder value (32%) and economic considerations (32%).

But the growth of sustainability reporting has been met with
an onslaught of criticism by anti-corporate groups and civil society
organizations who claim that companies are using these reports to green wash
what is otherwise business as usual, thereby disguising their destructive
behaviour. Some of these criticisms are
not necessarily unfounded. A quick look
on the first few pages of mainstream sustainability reports and the reader will
be bombarded with large high gloss pictures of the rural poor, for example, smiling
ear to ear for all the wonderful things the company has done for them or of
green pastures fronted by a farmer and his/her partner with seemingly content pigs
and cows enjoying life as they collectively watch the beautiful sunset.

Yet these same companies find themselves on the front pages charged
with complicity in major social, ecological, and governance issues like the death
of over 1100 people in the 2011 collapsed Bangladeshi garment factory (Loblaw,
Wal-Mart), the mistreatment of animals revealed through undercover videos (Tyson
Foods), the contamination of natural ecosystems (DuPont), the laundering of money
for terrorist groups (HSBC), or the rigging of centralized interest rates by
inflating or deflating their own rates to profit from trades (major banks). If you look at the sustainability reports of the
companies associated with these charges, you’ll find a completely different
story, one that conveys the firm as a beacon for corporate responsibility.

With these inherent contradictions growing in number, there
is a widespread need across multiple stakeholders to effectively evaluate a
sustainability report to see whether the claims embodied in the report are in
fact testament to their commitment to sustainability. How does an analyst distinguish rhetoric from
reality when assessing whether a company is prepared for increased environmental
regulation? How can the consumer figure
out which sustainability report is in fact a reflection of a serious commitment
to sustainability rather than greenwashing?
How can an investor, concerned about the risk associated with investing
in a firm that overlooks social and ecological externalities, figure out which
sustainability reporting firm is more or less risky? And how would an NGO know which firm is
legitimately addressing issues? In the
absence of available information, all of these stakeholders want to know how to
objectively evaluate a company’s adoption level of sustainability using the
information provided in the report.

This feels like a daunting challenge considering the
millions of dollars allocated to marketing and brand development that include
reporting tactics meant to convince the reader that their commitment to
sustainability is genuine. What is more,
unlike the institutionalized nature of financial statements that multiple
stakeholders can rely on as a means of comparison, there is virtually no
legitimate and substantive equivalent for non-financial indicators. While there is growing commitment to the
Global Reporting Initiative – a standard set of non-financial measures
companies agree to provide to be a member – the measures are regularly
criticized because they are self-reported and require no substantive basis upon
which to demonstrate authenticity in the commitment to sustainability. For
instance, one of the required measures under the social dimension is to
indicate whether the company provides employees with training on human
rights. A simple ‘yes’ or ‘no’ question
means that the company is not obliged to indicate the content of the training,
how long it lasts, whether it was provided by professional independent bodies
and, perhaps most importantly, whether there is any enforcement of employee
behaviour based on this training.

Despite these challenges, a growing repository of tools is
emerging to assist readers in conducting evaluations of companies along
non-financial indicators. Introduced
here are four such criteria one can consider when reading a sustainability
report. Incidentally, an important and
often overlooked consideration across these criteria is to assign as much value
to what is missing from the report as
to what is in it. Let’s look at the four
criteria in more detail:

1. Purpose of
Reporting

The reader should begin by trying to uncover the overarching
purpose of the report. This is less
difficult than it might seem. To
simplify, imagine a continuum that reflects the purpose of reporting where on one
side the main purpose is for marketing and public relations while on the other
side the main purpose is organizational development and change towards
sustainability where only what is measured can be managed. These are highly different objectives and
there are signals in the report to help the reader position the report on this
continuum and simultaneously determine their commitment to sustainability. Let’s consider the first side of the
continuum. Most companies still use the report for the purpose of
marketing. The company’s objective in
this instance is to paint a positive picture of their relationship with society
and the environment, oftentimes to deflect any negative publicity they might
have received. Signals of this in the
report will be obvious, such as the fact that the company doesn’t report on
anything negative, doesn’t acknowledge any bad publicity they might have
received or, more importantly, on what they are trying to do to rectify issues
or criticism they are facing. The reader
will also get the impression that much of what they’re presenting in the report
has very little to do with their core business.
Much of the content will discuss their philanthropic endeavors and
charity giving. For instance, a mining
company might avoid reporting on its actual relationship with the community but
will instead report on the amount of money donated for community causes. Similarly, a bank will disclose how much they
have spent on charitable groups but will avoid presenting the extent to which
their daily business decisions that can affect these very charitable groups are
considering social and ecological issues, such as whether they are curbing the
provision of finance to companies with poor environmental records. With this in mind, readers of a report that
is on the marketing side of the continuum will perceive an alarming sense of
hypocrisy in what is presented. From a
stakeholder perspective, the company’s objective in reporting is to appease
concerns, to quell criticism, and to defend their behaviour by providing
evidence of positive contributions to the groups these stakeholders care
about. Fundamental, like many marketing
strategies, the purpose is to divert attention away from relevant social and
ecological issues to give investors, consumers and government the impression
that the company “can’t be that bad.
After all, look at all the good they are doing”.

On the flip side, companies may also use the report to
facilitate organizational change towards greater performance in
sustainability. Here companies hold
employees and managers accountable by reporting on performance levels across
non-financial indicators. Now made
public, there is greater pressure by these organizational members to
demonstrate improvement. It also sends
an important signal to employees that the company is closely monitoring social
and ecological performance as a fundamental attribute of their organizational
processes. At the extreme, companies
would use this report as one of many mechanisms to transition the company where
sustainability is fundamental to its existence.
With this in mind, the focus of the report is less on philanthropic
initiatives and more on the performance along social and ecological dimensions
as they relate to the core business of the firm. Readers therefore get the sense that the
company is reporting comprehensively.
That is, rather than presenting small parts of their business that might
be doing well, they are reporting across all dimensions of the business. From a stakeholder perspective, the goal is
not to appease stakeholders but instead to engage them. More progressive reports provide detailed
accounts of stakeholder interactions, publishing stakeholder input and
providing avenues through which stakeholders can get involved in the company’s
performance. Put another way, the
report’s purpose is not to report on the past but to facilitate a platform for
discussion in the present. A fundamental
difference between these two objectives is that the second is using this report
as a mechanism for change, to hold those in decision-making authority
accountable for these issues by explicitly reporting them.

2. Metrics and
Performance

The second criterion used to evaluate a sustainability
report is perhaps the most intuitive of the four. It asks what the company is measuring and how
well they are performing on these measurements.
Again, we can use a continuum to understand the disparity in reporting
practices. On the one hand, companies
with poor reports provide stories and anecdotes while listing the many awards
they have received related to social and environmental performance. Importantly, these stories and anecdotes are
just that – they are not representative of the performance of the firm more
broadly. The report will be full of
‘feel-good statements’ as proxies for performance levels. If the company on this end of the continuum
did use measures, they would be very vague and ad hoc, likely customized in
such a way that they can demonstrate positive performance. For instance, a product’s environmental
footprint encompasses a wide range of components including its carbon
footprint, water footprint, materials footprint, among others. But companies may choose to only report on
those components of the environmental footprint that improved while omitting
others. At the same time, measures they
are using for one of these footprint components are not provided within any
context. For instance, a company may
indicate that its water usage has decreased by 2,000,000 litres or its carbon
footprint has been reduced by 25%. In
the first instance, there is no reference point to gauge how much of a drop this
represents. For the second, without the
use of a benchmark such as sales or number of employees, both of which are
common proxies for company size, this percentage drop is meaningless. Omitting this information leaves open the
possibility that the company got smaller by 30%, indicating that its carbon footprint
as a percentage of dollars sold or employees actually increased. Similarly, companies often fail to provide
historical performance levels, from which readers can assess performance over
time.

Companies
on the other side of the continuum provide readers with a comprehensive
snapshot of their performance over long periods of time (or at least when they
starting reporting on these items). Highly progressive companies will also provide
performance indicators on the entire supply chain rather than on the firm
exclusively. Although a more daunting
feat, several companies are doing this now to provide readers with the full
product life cycle analysis that includes the social and ecological footprint
of the raw materials all the way to the disposal of the product. Apple,
for instance, provides the ecological footprint of all components and stages of
the product’s manufacturing, including those activities done by contractors
used to make the product. That said,
they are not yet able to include the environmental footprint of second and
third tier suppliers with any level of accuracy. More obviously, the reader is easily able to
see improvements in the company’s performance over time or, perhaps less ideal,
transparency in the areas where they need improvement. Apparel company Patagonia pioneered an
initiative that provided consumers with a detailed breakdown on the carbon
footprint of their products. Incidentally,
their honesty was more important to the consumer than any claims that they had
the lowest carbon footprint among competitors.

3. Future Commitment
and Progress

The third criterion readers should
consider when evaluating a sustainability report is the extent to which the
company provides future targets and reports on progress to these targets.Because many companies consider
sustainability reporting as a marketing initiative, readers are often
frustrated with a lack of information on what they plan on accomplishing in
future years.Equally frustrating is
when companies provide numerical or qualitative targets but give little or no
action plan on how they plan on achieving those targets.Naturally questions of concern emerge such as
how executives are going to make sure that these targets are achieved, how are
they being worked into their performance evaluation, who is overseeing these
targets, what resources have been expended for the achievement of these targets,
how will the firm ensure that employees are involved at contributing to these
targets, and what happens if they don’t meet these targets. With this in mind, targets would need to be
incorporated into the existing management systems of the firm.The reader needs to know how and to what
extent these targets are incorporated into executive level decision-making.Are
these non-financial measures prioritized alongside other traditional employee,
manager, director, and VP performance expectations or does it reside
exclusively with the CSR manager?These
sorts of questions are instrumental and should be laid out in the report
because they give the reader some sense of how feasible it will be to achieve
these targets.

In addition, the company often
fails to provide detailed summarizes of how well they’ve progressed on targets
they’ve set in the past, with details on how and why they’ve struggled to meet
their targets and what they intend to do to make up for the failure.All of this information is pivotal for any reader
to make a sound judgment about whether sustainability is being taken seriously by
and in the firm.Oftentimes, employees see
progress on non-financial measures in the same sustainability reports read by
external stakeholders, meaning that they don’t feel any sense of urgency in the
need to achieve these targets in their everyday behaviour.Although this goes without saying, the
targets set out by the firm should be stretch targets that demonstrate that the
firm is interested in pursuing radical change towards sustainability.Incremental changes, while still improvements,
are less demonstrative of a company’s commitment to sustainability than those
targets that push the company into thinking of radical ways of operating.That said, the fact that they set targets
represents more of a commitment than not revealing any targets at all.

4. Legitimacy

The final criterion relates to the
legitimacy of the report.The more
obvious indicator of this criterion is whether the report is audited by an
external, objective organization.That
said, auditing doesn’t evaluate the performance of the company along
non-financial measures, nor does it evaluate the types of measures used.It only verifies that what the company is
saying in its report is accurate.This
is indeed a start no doubt.But
measuring the legitimacy of the report goes beyond whether it was audited.The reader needs to ascertain whether the
company selected its non-financial measures or whether they got their measures
from an established source or is using measures that have become standard by
external stakeholders.Too often,
readers are fooled by impressive numbers without realizing that the company
made up particular measures that allowed them to bend their data in ways that
looked good.Consider an oil and gas
company’s efforts to report on their community commitment.There are a number of social impact
indicators out there along with many qualitative indicators the firm could rely
on from independent organizations, however many of them use their own made up
measures such as the number of children that have attended a particular school
they support or the number of patients served at a hospital they support.For the latter, while having a health
facility available is important, there is no indication of whether the
community is positively impacted by it partly because it neglects to consider
that the increase in patients may not be due to the presence of the facility
but instead by the absence of education and preventative measures that are more
effectively at improving social welfare.

Low levels of reporting legitimacy
are also associated with high level performance indicators that lack the raw
data through which readers can follow the trail of how the measure was
calculated.Readers of progressive
companies are able to verify the claims put forward by companies.Balancing the need for more raw data is an effort to make the report user friendly for the reader.Believe it or not, some reports are so poorly
formatted and disorganized that the reader is unable to find critical
information within a reasonable amount of time.Legitimacy also represents the extent to which external stakeholders are
involved in the creation of the report.Very seldom do companies present data they collected with those critical
of their performance.Although some NGOs
are hostile, most are very eager to work alongside the company to collect and
measure performance levels.Their
involvement provides a fundamental source of legitimacy.Finally, as already mentioned, legitimacy
stems from the incorporation of reporting measures into the systems, processes,
policies, and procedures that already exist in the firm so that it garners as
much attention from key decision-makers to those at the front lines as other
business activities.

In sum, sustainability reporting
among companies is at unprecedented levels.Yet our ability to assess these reports in such a way that we can confidently
and objectively determine performance levels to compare firms with one another
is very limited.The above four criteria
represent a starting point in this direction.